Personal Finance: Diamonds aren't so rough

THE MARKET crash has sent investors scurrying for commodities which will be proof against the slump in shares but still give a strong rise in value as soon as growth resumes. Gold, platinum and diamonds are often used as refuges in times of uncertainty.

Gold has again proved its value in places like Indonesia, Malaysia and Russia where the currencies have collapsed. But gold earns no interest, and although it was a good investment in the 1970s when inflation was high, in recent years it has failed to provide investors with much protection. Platinum and palladium have performed better than gold, but prices are still well below their best levels.

Oil prices are even more depressed at the prospect of a recession and falling demand. Mining shares reflect this. Rio Tinto shares have fallen 40 per cent from their peak last October, although dividends are good. Lonrho, which is now a pure mining company after hiving off its other interests in May, has also fallen by a third in the last year, but the shares now yield 8 per cent.

The price of cut diamonds is still tightly controlled by the De Beers cartel. The cartel invites buyers for the jewellery trade to make sealed bids for parcels of gemstones. There is no secondary market for small investors.

A number of punters got their fingers burned in the 1970s when there was a brief speculative boom in diamonds as a retail investment and hedge against inflation. Small investors found themselves having to try to sell second-hand stones back to retail jewellers and discovered to their cost that the margins between buying and selling are very wide, and fashions in cut stones change.

But the diamond market as a whole is still relatively stable, partly because the cartel maintains a balance between supply and demand simply by reducing sales when demand is likely to be weak.

Investors who want a piece of the action will do better to buy shares in diamond companies. Shares in De Beers currently reflect the fact that it is having to hold substantial stocks to manage supply and demand and maintain its policy of gradually increasing prices just ahead of inflation. Last week De Beers shares were trading at pounds 8.50, compared with almost pounds 20 a year ago. At that price they are valued at nine times annual earnings.

Although De Beers still controls up to 90 per cent of worldwide diamond sales, there are a few independent producers that in effect ride on the back of De Beers and the cartel, exploiting the price stability.

Firestone Diamonds was formed in 1996 to mine alluvial diamond deposits in South Africa, and it floated on the Alternative Investment Market earlier this year at 114p a share. It was caught up in the downturn in share prices and is now trading at around 86.5p.

There is no immediate prospect of a dividend but the company hopes to declare a profit in the current year which ends in June 1999. The shares look a better bet at 86.5p, given the expected stability in the diamond price relative to most other economic variables. The main threat to an investment in diamond shares is the political outlook in South Africa.